Financial institutions in the United States have so far been spared the rise in customer delinquencies and losses on unsecured loans that many had forecast would accompany the spread of COVID-19. Popular explanations include the low levels of consumer delinquencies in unsecured credit coming into the crisis, the reopening of commerce in many states, and support from federal stimulus money for many consumers and businesses. However, conditions may be changing. The timing and location of accelerated reopening have coincided with increases in COVID-19 infection rates, and several states have reassessed their reopening strategies. Throughout, unemployment claims have remained elevated, and significant uncertainty exists about the future of key government policies, including extensions to federal unemployment payments, affecting household finances.1
For a perspective on where things are headed, we analyzed the likely impact that continued unemployment and a scaled-back government response would have on US household budgets. The results point to a potential marked increase in financial distress in the US over the next three months. Unless government stimulus money keeps flowing at rates similar to the first six months of assistance or a solution to the ongoing high rates of COVID-19 infection is found, as many as 7 to 8 percent of American households may struggle to cover their normal expenditures, compromising their ability to make payments on existing unsecured loans and credit cards. To mitigate the worst impacts of such an outcome, we recommend that lenders quickly adopt the ABCD of customer assistance: accelerating advanced analytics, building new capabilities, capacity planning, and expanding use of digital channels.
Unsecured loan delinquency rates stayed low in Q1–Q3 2020
Contrary to the fears of many during the early spread of the coronavirus, US lenders did not see a rise in unsecured delinquencies during the first three quarters of 2020 (Exhibit 1). In fact, total bank-card balances fell dramatically in recent months, from an all-time high of $859 billion on March 11 to $755 billion by late September.2 The proportion of credit card accounts that are delinquent dropped to 2.42 percent at the end of Q2 2020, and charge-offs are at 3.91 percent.3 For unsecured consumer loans beyond cards, delinquency rates were also low from a historical perspective, at 1.98 percent at the end of Q2 2020. Our research shows that consumers, aided by stimulus payments, exhibited responsible credit behavior and paid down debt in a period of economic uncertainty.
Enhanced financial support from government programs is one of three likely reasons for low delinquencies
Reasons for the absence of widely anticipated delinquencies probably include a combination of low delinquencies entering the crisis, efforts to reopen businesses quickly, and stimulus payments to consumers from the federal government.
In February 2020, consumer delinquencies and losses were at historical lows, following steady declines since 2010. Available credit was abundant, and unemployment rates were below the traditional healthy participation rate of 4 percent. Similar conditions existed at the end of 2019: total consumer non-mortgage borrowing topped $4 trillion,4 and delinquencies and losses were below 2.4 percent for non-mortgage consumer loans.5
The initial response to the pandemic’s arrival in the US caused a sudden peak in unemployment rates in April 2020. However, following an apparent stabilization of COVID-19 infection rates in May, many US states, especially in the south and west, began an accelerated program of reopening. Many employees in the service industries—in particular, those who had been furloughed—returned to work, and the official unemployment rate fell from 14.7 percent in April to 11.1 percent in June.6 In August, the rate fell further to 8.4 percent.
An even more significant factor in debt repayment has been enhanced financial support from the government, including the compensation programs funded by the Coronavirus Aid, Relief, and Economic Security (CARES) Act. A University of Chicago study estimated that around two-thirds of workers were eligible for unemployment insurance benefits exceeding lost earnings.7 As a consequence of substantial heterogeneity in earning distribution in the US, income expanded for the majority of claimants. According to our analysis of the data from the Chicago study, and of household income data across the United States, a majority of the nearly 50 million Americans who filed initial unemployment claims since March were receiving more in unemployment benefits—unemployment insurance (UI) and COVID-associated Federal Pandemic Unemployment Compensation (FPUC)—than they had been earning when they were employed.
In addition to CARES ACT measures to support income, many households are benefitting from mortgage and rent payment forbearance; further assistance could come (for renters) from the Trump Administration order suspending eviction for many renters until the end of the year.8
The future of low delinquencies in unsecured lending is far less certain
The continuation of low delinquency levels relies on a sustained economic recovery—and such a recovery depends largely on three current conditions, none of which are certain to remain in place.
Continued drop in COVID-19 infection rates
A strong and enduring economic recovery is most likely when the rate of COVID-19 infections falls and stays low. However, despite a gradual decline in the number of daily new confirmed cases of COVID-19 in the United States from around 30,000 in early April to under 20,000 in early June, new confirmed cases began to rise rapidly in mid-June and regularly exceeded 70,000 in late July. After this point, daily confirmed cases began another gradual decline, but were still at roughly 40,000 at latest count (October 5) (Exhibit 2).9
Decline in unemployment rates
Another condition that would help preserve low delinquency rates is low unemployment. Unemployment rates at a national level and for some of the most populous states started to trend down in May and continued to do so over the summer (Exhibit 3).10 However, the resurgence of the virus in some of the largest states has been reversing this trend, keeping unemployment rates high or, in some cases, pushing them higher.
To address unemployment, the federal government has provided stimulus money to a number of large corporations and 1.6 million small and medium-size businesses through CARES Act programs including the Paycheck Protection Program.11 The condition for such loans was retention of staff on the payroll for at least six months. After this period—typically expiring in October–December 2020 for loan applications submitted between March and May 2020—employers can lay off furloughed staff.
Additional and ongoing unemployment benefits
Given the potential for continuing high unemployment, a third factor associated with low delinquency rates is ongoing financial support from the federal government for unemployed workers. The main source of extraordinary support—the Federal Pandemic Unemployment Compensation (FPUC)—expired on July 30 and the 26 weeks of state-administered Unemployment Insurance has expired for many workers (Exhibit 4). In August and early September, a majority of states participated in the FEMA-funded Lost Wages Assistance (LWA) program, but this program usually includes only $300 weekly payments for up to 6 weeks and the allocated FEMA funds are rapidly being exhausted.
In parallel, Congress has yet to agree on terms for a fifth economic-stimulus package that would supplement and extend existing programs. As of this writing, multiple options are being debated.12
The lack of a consensus suggests that even if a stimulus package passes the House and Senate, the process could take several weeks or months, with payments of any assistance to workers and employers not beginning until after the law’s passage. In the interim, households that already are struggling to balance their budgets could become delinquent. Furthermore, the exact magnitude of the gap in household finances is unclear, because many states are still processing backlogs of claimants from current stimulus programs.
Without further economic support, widespread economic hardship may be just weeks away
Our analysis indicates that in the absence of continued government support, delinquencies could reach a level more than three times higher than recent historical averages, and persist for at least the next two to three years.
The risk facing banks is sobering: the conditions associated with preventing a surge in delinquencies are both difficult and critically important. Unless the necessary conditions are met, many households without jobs and without assistance will become unable to cover their expenses. Inevitably, some of those households—perhaps a sizable share—will default on their loans. (For details on how we measured these consequences, see sidebar, “How we arrived at our estimates.”)
Lack of financial support causes widespread economic hardship
In the absence of a proven vaccine for COVID19 or a treatment that ensures rapid recovery, US households’ economic health increasingly depends on sustained stimulus support from the government. For example, according to recent McKinsey surveys of US financial decision-makers, more than 50 percent of borrowers who have already applied for mortgage forbearance say they will not be able to resume payment at the end of the forbearance period and will require some form of assistance or loan restructuring. This is consistent with anecdotal reports from the industry’s largest lenders.
According to research published by the University of Chicago,13 68 percent of unemployed workers were eligible for unemployment insurance benefits that exceeded their lost earnings. This was possible because the CARES Act sent a fixed $600 weekly payment to all eligible unemployed workers. Those who had been earning less than $600 a week thereby received assistance greater than 100 percent of earnings replacement. The median replacement rate has been calculated at 134 percent.
When the UI supplement drops, some unemployed households’ earnings will fall below their previous wage—the larger the drop, the greater the number of people for whom this replacement wage will be under 100 percent (Exhibit 5). Our financial decision-maker survey indicates that on average households receiving UI can absorb a decline of roughly 40 percent in monthly income before they may begin to fall delinquent on credit card payments. For context, in our most recent surveys, credit card and personal loan payments are ranked fourth in terms of priority, after daily necessities, bill payments, and mortgage/rent.
So, for example, a $400 weekly stimulus payment could become insufficient for roughly 25 percent of unemployed households to cover credit card bills. Assuming a 9 percent unemployment rate, this could mean that roughly 2 percent of all households will fall delinquent on credit card payments, inclusive of current delinquencies. Using this same reasoning, a $200 weekly stimulus payment could lead to credit card delinquencies of about 4 percent. And if stimulus payments fell to just $100 per week, roughly 6 percent of US households might struggle to service their loans.
To illustrate the potential impact, we consider the future income and expenditure of an example household (Exhibit 6). For this household, weekly earnings prior to March were $673 per week ($2,920 per month) and PUC payments were reduced to $300 per week after July 31. Their state unemployment insurance ran out by the end of September, 26 weeks after the household filed for unemployment and began receiving state UI payments.14 The household’s expenses before the pandemic were $2,900 per month (based on median expense figures). We assume the household was able to compress 30 percent of its expenses starting in March15—initially, reduced activity and expenses due to the lockdown (e.g., food outside home, gas) helped with the compression; but over time, as activity increases, the household may be required once again to prioritize expenses.
Under these conditions, our example household barely broke even in August and September, and would no longer be able to cover their expenses and loan obligations by October. Depending on forbearance programs from their lenders and their ability to tap into savings, accounts belonging to such customers could fall delinquent by the end of November and could begin to charge off by the end of March 2021 (closed-end loans like auto/mortgage) or by the end of May 2021 (open-ended loans such as credit cards).
Households at different income levels will experience the declines in different ways. On the one hand, for those with the lowest income levels, even moderate stimulus payments may still exceed prior income levels. On the other hand, households with higher incomes (the top 2 or 3 deciles) are likely to have more savings and thus the resources to service their debt payments for longer—potentially for 2 to 3 months. Moreover, these higher-income households have suffered lower unemployment during the pandemic. Households in the middle and mid-to-low income brackets, however, will face the greatest hurdles to making ends meet: higher unemployment levels and lower savings than higher-income households; and stimulus payments insufficient to cover their prior level of expense.
Following such hardship, delinquency and loss rates could rise dramatically
Insights from our latest consumer-sentiment survey suggest that in the event of a reduction of federal stimulus payments to households (which we started to see in early August) , payments on credit-card debt and other unsecured loans will be deprioritized the most, in favor of daily necessities. Given current outstanding bank-card balances of $751 billion, delinquencies could reach a level of around 6 percent, or up to $45 billion in three months, more than three times the recent historical average for that product.
Extrapolating our current delinquency forecasts to full-year estimates and assigning a loss given default (LGD) estimate of 30 percent (which is 9 percentage points above relative historical averages), we arrive at a rolling 12-month charge-off figure of $110 billion, more than three times the 2019 figure and close to our prior published estimates.16
Given the pattern of prior recessions, an economic shock of the intensity observed so far, combined with at least 6 to 12 months to achieve widespread vaccinations, suggests that elevated delinquencies could persist for at least the next two to three years. Further economic impacts could persist even longer.
Lenders can act now to mitigate losses
While the additional unemployment benefits and economic-stimulus payments over recent months have aided many lower-income households, leading to a decline in overall household debt, the future financial health of many US households seems increasingly uncertain. This uncertainty is the primary challenge for lenders planning structural changes in their customer-assistance programs. Now, as medical professionals help reduce the spread of COVID-19 infections and federal and local governments decide on any future stimulus programs, lenders also can take actions to mitigate losses.
Lenders can offer greater leniency and develop alternative customer-assistance solutions for borrowers experiencing hardship. Programs that reduce minimum payments due without eliminating them entirely appear to be a healthy compromise, reducing the financial burden on consumers while maintaining their loan obligations.
Lenders will benefit from developing new approaches and solutions that extend beyond the early-COVID-19 approach of offering payment holidays. As we noted previously, empathy and creative solutions can deepen customer loyalty. In particular, we suggest four new opportunities that lenders should act on to provide standout assistance to customers facing economic hardship:
- Advanced analytics. Create new options for loan restructuring and new policies for suspending or reactivating credit lines for higher-risk portfolio segments identified through advanced analytics. Some segments may be entirely novel, because of the direct impact of COVID-19. Examples of options include converting credit card revolving balances into a closed-end installment loan, offering reduced settlements, or reactivating limited credit lines for some recovering customers, even those in late delinquency.
- Building capabilities. Develop new talk-offs for customer-assistance associates, focused on truly assisting customers rather than prioritizing simple economic outcomes such as payments taken. Redesigning the call model to include more detailed conversations about income and expenditure with customers exiting deferment programs will provide valuable information to enhance risk-segmentation models and enable more tailored assistance.
- Capacity planning. Lenders can use fresh customer insights to inform updated customer-assistance strategies. They can update loss forecasts according to a detailed understanding of economic impact by income decile and under low, medium-, and high-severity economic scenarios. Using those forecasts and subtracting the benefits of self-cure and self-serve channels, lenders can more accurately predict capacity demand and staff up accordingly. Managing and sequencing the expiration of payment holidays according to value at risk will enable lenders to flatten the curve of customer demands over several months, rather than confronting a cliff face of borrowers becoming newly delinquent all at once.
- Digital channels. Providing self-serve journeys via digital channels instead of relying on conversations between customers and associates addresses customer preferences for digital communication. Digital channels also enable tighter control and compliance with regard to customer outcomes. Effective two-way communication (including financial education) via digital channels is especially important during periods when customers are not making regular payments.
Pragmatically, lenders alone cannot resolve the risk of imminent economic hardship facing many Americans. We have witnessed a degree of inevitability about the spread of the COVID19 in the United States and consumer doubt about the safety of returning to workplaces and businesses they once frequented. Until much stricter social controls can be followed or vaccination against the virus is widespread, we expect that economic fundamentals are unlikely to improve within the next few months. The consequences will be eased if, as we anticipate, federal and state governments approve and distribute additional financial stimulus money. But as long as economic support for households is uncertain or more limited than during the early months of the pandemic, lenders are well advised to strengthen their customer-assistance and loss-mitigation programs.